Pound Foolish

Kit McMahon

In Politics and the Pound, Philip Stephens has produced a book which should be required reading for anyone aspiring to be either Chancellor or Prime Minister. Let’s hope Gordon Brown and Tony Blair are studying it carefully. They can legitimately enjoy the more egregious mistakes made by the Tories since 1979, but they should be sparing with their scorn. They should remember the errors of previous administrations; and be thankful they did not win the last election and inherit an ERM membership which they had supported when in opposition.

Stephens’s judicious narrative of the turbulent economic events of the period provides a necessary sceptical gloss on the one Nigel Lawson gives in the thousand pages of his View from No 11. It draws on the testimony of many senior officials and other participants, who persuasively dispute Lawson’s view at many points and have not hitherto had an opportunity to state their case. But Stephens’s purpose is not so much to write a history of the recent past as to explore the twists and turns of policy towards the exchange rate and the effects these had both on the economy and on the politicians themselves. Managing the exchange rate is tricky for governments at the best of times. It is clearly a price (the price at which one currency buys another), playing a large, though much disputed, role in reflecting, transmitting and instigating economic trends. Equally clearly, it is symbolic of the doctrines and actions of a government and of how it is viewed by foreigners. Finally, because it measures the value of the nation’s currency against some other currency or asset, it can never be more than partially under a government’s control.

Given the relatively inferior economic performance of the UK compared to her main competitors for over a hundred years, and the painful decline for nearly as long from an international pre-eminence embodied in the widespread use of sterling, it is not surprising that virtually all modern British administrations have failed for a good deal of the time to manage the exchange rate successfully – even before it became entangled with the equally intractable problem of how to handle Europe.

At bottom, the policy a government adopts towards the exchange rate is an aspect of a deeper policy decision: whether to commit itself to a set of rules or to rely on pragmatic discretion. Those in favour of rules can point to the operation of the Gold Standard before the First World War and the Bretton Woods fixed exchange rate system after the Second, as both providing, through their constraints on national policy, a benign environment in which international trade and economic growth thrived. As examples of the dangers of unfettered discretion, they can point to the destructive chaos of the interwar period and the disastrous worldwide inflationary boom of the early Seventies, by when the Bretton Woods system had collapsed and governments no longer felt constrained by exchange rates or any other discipline.

Lawson, the prime exponent of the policies embraced by the Tories when they came to power, has never made any secret of his belief in the necessity for a clearly defined framework of rules. But by 1979 it was clearly impossible to reconstruct a global fixed exchange rate system. One alternative possibility, chosen in 1978 by all the members of the EEC except the UK, was a mini-system, the ERM. Callaghan said at the time that the UK would join, but only ‘when the time was right’. As repeated endlessly by Thatcher, this phrase became an embarrassing euphemism for never. But in 1978 the time was genuinely not right and was recognised not to be so by our partners – a point not made by Stephens. As a petro-currency, sterling was likely to be destabilising because any movement in world oil prices would push it and the other EEC currencies in opposite directions.

In these circumstances, the Thatcher Administration chose a set of domestic rules: establish and publish medium-term targets for the growth in the money supply and the evolution of the public sector borrowing requirement; abjure any discretionary (i.e. ‘Keynesian’ counter-cyclical) use of fiscal policy; and have no policy at all towards the exchange rate.

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